The True Value of Insurers’ Float, by Tom Mielenhausen, offers an excellent view of how insurers profit from delay and denial. Mielenhausen noted that:
[I]nsurance companies borrow money from policyholders interest free. Insurers enjoy the use of free money and get paid for holding it.
The true value of a property/casualty insurer’s float, therefore, is not merely the “return-on-investment value” – i.e., the return the insurer makes by investing premiums in bonds and other investments. Rather, the true value of the float also consists of the “use value” of the money the insurer borrows from its policyholders, which can be measured by the avoided cost of borrowing the money (typically two percent or more above the prime rate). If an insurer were required to disgorge the true value of the money it kept while erroneously denying coverage, it would pay the cost of borrowing that money plus any return on investment during that time.
When both the use value and return value are taken into account, the true value of the property/casualty insurer’s float far exceeds the single-digit rate of prejudgment interest set forth in a number of state statues. As a result, an insurer involved in coverage litigation in those states has little incentive to timely resolve the claim. In those states, legislative reform is due.
It reminded me of last year’s post, Partial Payments of Insurance Claims and Claims Delay – A Need for Higher Interest Rate Penalties and Claims Practice Regulations, where I show my agreement with Mielenhausen by claiming:
There is an extraordinary need for regulators and the law to reflect a public policy that all insurers should pay claims as soon as they can determine amounts due. Partial payments of amounts determined to be payable should be the standard, and extreme penalties should be the norm for slow paying insurers seeking to wrongfully profit from "playing the float."
In Playing the Float and the Wisdom of Warren Buffett, I argued that honest and prompt-paying insurers are harmed by not having fair claims practice laws and regulations that penalize wrongful and slow-paying insurers:
In the insurance business, it is economically efficient to cheat or underpay claims—-if the insurer does not get caught or never has to pay for such sin. Honest insurers that provide first class treatment, rather than merely talk of first class treatment, are at an economic disadvantage. Most people buy insurance based on price, not recognizing that the low cost insurer may offer an inferior product in the small type or in the actual claims performance.
Fair claims practice lawsuits are important because they represent the few public presentations of how bad the insurance industry is at claims performance. Unfortunately, because there are so few of these suits and the "market conduct studies" run by the departments of insurance are significantly flawed, there is little chance that insurance cultures of paying too little or paying far too late will be stopped. The result is that companies that engage in such behavior have an economic advantage over honest insurers because they can maintain profit margins at lower rates. Being able to charge less is key to economic success in the insurance business.
Whenever insurance company lawyers and lobbyists argue against high prejudgment interest rates and Unfair Claims Practice laws, every judge and legislator should know they are really arguing for public policy supporting cheating and slow-paying insurance companies.
Thought For The Day
“Somebody once said that in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you.”